Should banks be financing farm real estate now?
BankBeat
By: John Blanchfield and Heather Malcolm
Nearly two years ago we wrote an article for BankBeat that urged bankers to help their farm and ranch customers hedge their interest rate exposure. Today there are a number of factors at play in farm real estate lending that cause us concern. As a result, we are urging community bankers to hedge their exposure to farmland lending risk.
Every Federal Reserve district bank is reporting hefty increases in farmland prices. Ultra-low interest rates are helping drive land prices. Is it too early to use the bubble word? And it isn’t just land prices; if you lend money to farmers and ranchers, you know there has been an explosion in prices for used machinery and all input costs. How long do these artificially low rates last, and what happens to asset values when rates start to climb?
Much of 2020 farm prosperity was driven by a tsunami of government payments of nearly $50 billion. Payments will still be relatively high in 2021, but there is a scaling back in the works. USDA is predicting an overall decline in net farm income of nearly 9 percent in 2021 and that is due in large part to a 45 percent decline (that is not a typo) in government payments. Historically, government payments are feast or famine. The coming correction in the overabundance in government payments will be brutish — and short.
Concentration risk is real; just ask your bank examiner. Community banks with a concentration in agriculture are at the whim of volatile markets. Consider this: In the past 24 months we went from a poor farm economy to a super cycle and now we seem to be coming back to earth. How the air gets let out of this one will be worth watching.
Competition between lenders is pushing a “permissive” credit environment, and the drive to gain new business can lead to shortcomings in underwriting. Trying to gain market share in this environment, using farmland lending as the catalyst, probably is not a wise strategy.
There are still opportunities in financing farmland today, but community bankers have to be willing to do things differently. Doing things differently isn’t always easy. For generations, banks that lent to farmers and ranchers had been portfolio lenders. Loans were originated and held in their portfolio. To counteract interest rate risk banks have shifted that risk to their customers by offering only variable rate loans. If you and your crew are still doing things the same old way, you could find yourself the last one standing when the music stops. “Doing differently” means laying off interest rate, concentration and credit risk. If you aren’t willing to re-engineer your bank’s farmland lending processes, then move to some other area of lending and leave agricultural real estate lending to those who know how to manage the risk.
Sound impossible? If there wasn’t a sizable number of community banks nationwide that have successfully re-engineered their farmland lending programs we would agree that it is. But, the fact is that community banks that have remained competitive have reworked their programs and are flourishing in ag lending today.
For example, at Bank of the Rockies we have utilized both Farmer Mac and the USDA Farm Service Agency guaranteed lending programs. Farmer Mac is a government sponsored secondary market for agricultural real estate loans that was created after the last great crash in the farm real estate market. FSA is a government guaranteed lending program. We would not have been able to expand our farm and ranch lending over the last several years if these two resources did not exist.
Farmer Mac is a risk transfer agent designed to assist banks that are originating farmland loans. Farmer Mac allows community banks to offer long-term, fixed-rate agricultural real estate financing to their customers because banks can sell the entire loan to them. This allows the customer to manage their interest rate risk while the bank manages concentration and credit risk. Bringing Farmer Mac to the table is a win-win-win situation for all parties.
USDA-FSA guaranteed lending provides a second outlet for a bank to manage its agricultural real estate lending risk. Bankers involved in agricultural lending understand that their borrowers sometimes have a bad year or two and that re-balancing the customer’s balance sheet may be needed. Or, the customer may be a new, undercapitalized producer purchasing farm or ranch real estate. These borrowers carry a little more risk, so an FSA guarantee is sought.
FSA provides a 90 percent guarantee on various loan types, with an aggregate debt to a borrower of $1,776,000 currently. Not only does a bank receive a government guarantee on 90 percent of the loan balance, they also have the option of selling the guaranteed portion. This provides an excellent return on the 10 percent portion of the loan that is retained in portfolio. Banks that have experience with the FSA guaranteed loan programs have the option of applying for Preferred Lender status which speeds up loan processing time and gives the bank more control over how the loan is serviced.
There is risk in farm and ranch lending, especially when the value of land is as overheated as it is today. Doing things the same old way in farmland lending could be dangerous for a community bank in this environment. Banks that want to stay in farm and ranch lending have to learn how to do things differently. Once the unique risks in farm and ranch lending have been mitigated, there are great opportunities for community banks in this space.
Heather Malcolm is vice president of agricultural lending at Bank of the Rockies in Livingston, Mont. She was the 2020 chair of the American Bankers Association’s Agricultural and Rural Bankers Committee. She can be reached at hmalcolm@botr.bank.
John Blanchfield owns Agricultural Banking Advisory Services, an independent consultancy that works for banks that lend money to farmers and ranchers. He can be reached at john.blanchfield@verizon.net.
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